The Rational Reminder Podcast
Episode 270: Victor Haghani and James White: The Missing Billionaires
Episode guests
Podcast summary created with Snipd AI
Quick takeaways
- Poor risk decisions and not considering uncertainty are identified as key contributors to the puzzle of the missing billionaires.
- Understanding risk and making coherent risk decisions is crucial in financial investing.
- Utility-based preferences can guide more effective financial decision-making and help investors navigate asymmetric return profiles and skewed expected return distributions.
- Options are generally not suitable for retail investors and should be used cautiously with a solid understanding of their complexities and limitations.
Deep dives
The Puzzle of the Missing Billionaires
The podcast discusses the book 'The Missing Billionaires' and examines why there are no billionaires today who trace their wealth back to the wealthiest families of 1900. The book explores the concept of making better financial decisions and highlights the challenges individuals and families face in growing and maintaining their wealth. Poor risk decisions and not considering uncertainty are identified as key contributors to the puzzle.
The Coin Flipping Experiment
The podcast explores a coin flipping experiment conducted by the hosts. Participants were given the opportunity to bet on a coin that was programmed to land on heads 60% of the time. Surprisingly, many participants made irrational and inconsistent betting decisions, illustrating the challenges of risk-taking strategies and bet sizing. The experiment highlights the importance of understanding risk and making coherent risk decisions in financial investing.
Expected Utility and Risk-Adjusted Return
The concept of expected utility is discussed, emphasizing the importance of understanding diminishing marginal benefits of consumption and the impact of outcomes on utility. The podcast explains the use of expected utility and risk-adjusted return as tools to evaluate and compare investment options. It highlights that utility-based preferences can guide more effective financial decision-making and help investors navigate asymmetric return profiles and skewed expected return distributions.
Options and Risk Management
The podcast delves into the topic of options in personal finance and investing. While acknowledging the usefulness of options in certain contexts, it concludes that options are generally not suitable for retail investors. The hosts discuss their skepticism towards options as they believe they don't align well with individual investors' preferences and risk management strategies. They caution against using options without a solid understanding of their complexities and limitations.
The Value of Expected Utility Framework
The hosts address the criticism surrounding the expected utility framework and expound on its relevance and applicability in normative personal finance recommendations. They argue that while deviations in behavior might exist, people's underlying preferences align with expected utility assumptions. The podcast emphasizes the benefits of considering risk, return, and utility in financial decision-making and highlights the potential for greater financial well-being when aligning behavior with utility-based preferences.
Key Point 1: The importance of understanding the connection between risk and return in investing
Understanding that higher returns are not possible without taking on more risks is crucial in investing. The efficiency and competitiveness of markets enforce this principle. It is essential to recognize that trying to achieve higher returns without an appropriate level of risk is unlikely and can lead to suboptimal investment decisions.
Key Point 2: The significance of properly sizing investments and considering spending strategies
Investors should pay as much attention to the question of how much to invest as they do to what to invest in. Sizing investments and determining the right amount of risk to take is often overlooked. Developing robust strategies for portfolio allocation and spending, considering factors such as risk aversion, time preference, and volatility tolerance, can help navigate through the ups and downs of investment decisions and contribute to long-term success.
If the wealthiest families of the past century spent a reasonable amount of their wealth, invested in the stock market, and paid taxes, there would be thousands of billionaires today. But there aren’t. So, what happened? To answer this question, we are joined by authors and finance professionals, Victor Haghani and James White. Their recently released book, The Missing Billionaires: A Guide to Better Financial Decisions, uses the missing billionaires puzzle to explore how and why most investors fail to capture the returns offered by the market. Victor was a founding partner of Long-Term Capital Management (LTCM), the multi-billion-dollar hedge fund that famously collapsed in 1998 and nearly took the global financial markets down with it. His participation in the downfall of LTCM led him to reassess much of the way he thought about investing, and in this episode, he shares some simple but powerful frameworks and personal finance recommendations. We also receive accessible explanations of the Merton model and expected utility theory from James, take a deep dive into dynamic asset allocation, discuss optimal solutions for lifetime spending, and learn more about the certainty equivalent return and Sharpe ratios, plus so much more. Whether you’re an entrepreneur invested in your own business or simply focused on building long-term wealth, Victor and James’ book (and this conversation about it) will be a valuable resource for better financial decision-making, so be sure to tune in today!
Key Points From This Episode:
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(0:05:19) The puzzle of the missing billionaires (and why it matters to Victor and James).
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(0:09:45) Some common but critical financial decision-making problems most people face.
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(0:12:39) Unpacking the coin-flipping experiment in their ‘What's Past is Not Prologue’ paper.
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(0:19:57) What investors should aim to maximize when sizing positions in risky assets.
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(0:24:22) An example that illustrates how the Merton model relates to bullish bets.
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(0:29:04) What the Merton share tells us about dynamic asset allocation if it is or isn't possible to estimate expected equity returns.
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(0:35:29) How real expected returns affect optimal risky shares for long-term investors.
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(0:37:29) Different ways to forecast volatility to determine the optimal risky share.
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(0:42:00) Easy-to-understand definitions of the utility curve and expected utility theory.
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(0:50:20) Using the certainty equivalent return and Sharpe ratio to evaluate investments.
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(0:57:56) Whether or not options belong in the portfolios of typical retail investors.
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(0:59:01) If expected utility is a good model for normative personal finance recommendations.
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(1:05:16) How Victor’s experience with LTCM affected him, both professionally and personally.
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(1:09:08) What optimal solutions for lifetime investing and spending look like.
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(1:22:22) Questions to ask yourself to work out your own utility function and risk aversion.
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(1:28:19) Victor and James’ parting financial advice and respective definitions of success.
Books From Today’s Episode:
The Missing Billionaires – https://www.amazon.com/Missing-Billionaires/dp/1119747910
Stumbling on Happiness — https://www.amazon.com/Stumbling-Happiness-Daniel-Gilbert/dp/1400077427
The Man Who Solved the Market – https://www.amazon.com/Man-Who-Solved-Market-Revolution/dp/B07P1NNTSD
Links From Today’s Episode:Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/
Shop Merch — https://shop.rationalreminder.ca/
Join the Community — https://community.rationalreminder.ca/
Follow us on X — https://twitter.com/RationalRemind
Follow us on Instagram — @rationalreminder
Benjamin on X — https://twitter.com/benjaminwfelix
Cameron on X — https://twitter.com/CameronPassmore
Cameron on LinkedIn — https://www.linkedin.com/in/cameronpassmore/
Victor Haghani on LinkedIn — https://www.linkedin.com/in/victorhaghani/
James White on LinkedIn — https://www.linkedin.com/in/james-white-b4310a47/
Elm Wealth — https://elmwealth.com/
When Genius Failed — https://www.amazon.com/When-Genius-Failed/dp/0375758259/
Where are all the Billionaires?: Victor Haghani at TEDxSPS – https://youtu.be/1yJWABvUXiU
‘What's Past is Not Prologue’ — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3034686
‘Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case’ – https://www.jstor.org/stable/1926560
‘Stock Prices, Earnings, and Expected Dividends’ – https://www.jstor.org/stable/2328190
‘No Place to Hide: Investing in a World With No Risk-Free Asset’ – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3903372
‘Sharpening Sharpe Ratios’ – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=325942
‘A Sharper Lens for Sizing Up Nickels and Steamrollers’ – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2874602
‘Do Options Belong in the Portfolios of Individual Investors?’ – https://elmwealth.com/do-options-belong-in-portfolios/
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